Analysis-French bond market gets taste of euro zone ‘periphery’ turmoil
2024.06.28 01:36
By Stefano Rebaudo
(Reuters) – The recent turmoil in France’s bond market could mark a new chapter for the euro zone’s wealthiest economies, with emerging political and fiscal risks fuelling volatility earlier associated with its high-debt members such as Greece or Spain.
French President Emmanuel Macron’s rattled markets with his shock decision on June 9 to call a snap election after his grouping got trounced by far-right parties in European parliamentary elections.
French government bond yields are around 3.25%, near their highest level of the year. That has pushed their premium over German yields – the European benchmark – to the most since at least 2017, reflecting the extra return investors want for holding that debt.
France is also now subject to European Union disciplinary measures over its budget deficit, together with Belgium, fellow member of what has been considered euro area’s low risk “core”, while former budget laggards Spain, Portugal and Greece are in the clear.
The terms “core” and “periphery” became commonplace during the euro zone sovereign debt crisis, which has driven a wedge between the richer north and the more indebted southern “peripheral” countries, both politically and from an investment perspective.
The “periphery” bonds were often the object of intense speculative trading at the first hint of any sort of setback.
However, the last few years have seen yield spreads for the euro zone’s rich-economy core widen, while those for the “periphery” countries have mostly shrunk, as they stuck to tough debt-reduction rules imposed after the crisis.
In fact, out of that group, in the last five years, only Spain has seen its spread over Germany widen, while Greece’s, Portugal’s and Italy’s have shrunk. The original core members, meanwhile, have all seen a widening, with France experiencing the largest increase.
“We think French government bonds will increasingly behave more like ‘peripheral’ rather than ‘core’ assets,” Felix Feather, economist at UK asset manager abrdn, said.
“While this distinction does not have quite the bite it once did during the euro crisis, when the ongoing membership of the euro zone seemed like an open question for many peripheral countries, it does mean that French bonds are likely to trade with greater volatility, pro-cyclicality, and persistently wider spreads to Germany,” Feather said.
The spread between German and French 10-year yields spiked to as much as 82 basis points the week after Macron’s announcement, prompting a warning from the French finance minister about the potential for a deeper crisis.
It is currently around 77 basis points, compared with fellow core members Belgium at 64 basis points, Austria, with 56 basis points, and the Netherlands at 33 basis points.
What has helped Spain, Portugal and Greece, largely contain their spreads, is investors’ preference for higher-yielding assets, particularly as long-dated bonds yield less than shorter-dated ones right now, known as “yield curve inversion”.
“With inverted yield curves, finding assets that beat cash is difficult. That’s why many people were holding on to their periphery bonds,” said Andres Sanchez Balcazar, head of global bonds at Pictet Asset Management.
Analysts said this stability was also due to credible debt reduction strategies implemented by some of peripheral countries and the pivotal role of the European Central Bank, which commits to prevent a potentially destabilising blow-out in spreads.
POLITICAL FOCUS
Marine Le Pen’s far-right National Rally (NR) leads in the polls ahead of the first round of voting on Sunday, and investors worry about the risk of a new government taking the country down an unsustainable debt path.
Various RN party members have sought to allay such fears by saying they would stick to Europe’s fiscal rules, which dictate a country’s budget deficit cannot exceed 3% of total national output. France is currently at 5.5%.
For Barclays, that means an RN majority might help bring France’s debt spreads down.
Citi strategists, on the other hand, think this gap could blow out to as much as 100 basis points, closer to Italy’s spread over Germany at around 156 basis points, if either a far-right or far-left government make big promises on spending.
Konstantin Veit, portfolio manager at major bond investor PIMCO, said he was fairly neutral in terms of positioning between the euro zone’s core and periphery, given how much Spanish and Portuguese spreads have narrowed.
“It’s true that over time if the current fiscal trajectory persists, you might expect Spain to trade closer to France and also see Spain trading through France,” he said.
Analysts and fund managers say politics remain in the spotlight for any issuer, not just France.
Portugal’s centre-right minority government could struggle to approve the 2025 budget. In Spain, its centrist parties contained a far-right surge in the European elections, but the centre-left government is expected to favour increased social spending.
“We think that they both (Spanish and Portuguese spreads) have 15-20 bps of tightening left,” Pictet’s Sanchez Balcazar said, assuming that an NR-led government sticks to European budget rules, with no further spillover effects from France.
While France is in hot water now over its finances, it is unlikely to be in the same category as Italy, the third-largest economy in the euro zone with the worst debt problems.
“At the end of the day, I think that France’s liquidity and the global safe-asset nature will keep its spread versus Germany a little bit tighter than that of Spain and Portugal,” said Reinout De-Bock, head of the European rate strategy at UBS.
